When I have wired the Regulator sensing wires + and - to respective House Battery terminals, what happens when the House battery fails?

Assuming House Panel and Starter are connected to the "C", Alt power (+) is direct to #1 house and the echocharger is not going to connect because the charger field is not activated and there is not adequate voltage to cause the echocharger to "combine".

1. Switch to #2 Bat Reserve to start engine. No problem.
2. Alternator Field - will not be activated if #1 Bat is 10.5vdc
3. Nothing will charge.

Yet we are told not to switch to "Both" as it may kill both batteries.
(If Both is selected, and if Batt #1 has enough partial charge current to activate the alternator field, then alternator may be put on a full load, pumping into both batteries.)

Do I have to move the Regulator Sensing wires to Battery #2 Reserve to get the alternator charging?
or reconnect the + / - sensing wires at the alternator?

You can use a pos dist busbar at the bank to connect to. You can then use a wrench to pull the banks main fuse or put a Blue Sea mSeries ON/OFF between the busbar and bank. In the event of an actual bank failure turn off the ON/OFF or pull the fuse then set to BOTH. These failures are extremely rare if practicing good battery care and you're replacing the bank before SOH gets too bad.